1. ENGG 401 X2 Fundamentals of Engineering Management Spring 2008 Chapter 2: Supplement Journal Entries and T-accounts Dave Ludwick Dept. of Mechanical Engineering University of Alberta http://members.shaw.ca/dave_ludwick/

2. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 2 ENGG 401 X2 – Fundamentals of Engineering Management Financial Statements “Show me the money!”Financial statements: “Show me the money!” Financial statements apply to all sizes of business, from a single proprietor corner store to a multinational company. Many financial statements are public information and available through the web Types of financial statements: –Income statements –Balance sheets –Cash flow statements (aka, Statement of Changes in Financial Position) –Statement of Retained Earnings –Statement of Owner’s Equity

3. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 3 ENGG 401 X2 – Fundamentals of Engineering ManagementAccounts An account is a detailed record of increases and decreases in a specific asset, liability, equity, revenue or expense item Separate accounts are kept for each type of asset, liability, equity, revenue or expense item. Balance Sheet accounts (like cash, AR, AP, etc) are “As at” accounts, showing the status of these items at the end of a period Income Statement accounts are “flow through” accounts, measuring the amount of revenue and expense occurring through a period A Chart of Accounts or Ledger is a list of all the accounts used by a company, often showing an account number

4. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 4 ENGG 401 X2 – Fundamentals of Engineering ManagementAssets Assets are resources available and controlled by the organization for current or future benefit Assets –Cash, the most liquid of all assets –Accounts Receivable: amounts owed to the company for goods or services provided through operations –Prepaid Expenses, advanced payments made for expenses. Prepaid expenses are assets until the asset is consumed (insurance, rent) –Equipment, are assets not sold in the course of operations, but used to deliver products or services (computers, desks, machinery) over the course of several accounting periods –Buildings and Land are assets because they provide a location in which to operate the business

5. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 5 ENGG 401 X2 – Fundamentals of Engineering ManagementLiabilities Liabilities are obligations to transfer assets or provide services to other entities. Liabilities –Accounts Payable: Money owed to suppliers for products or services bought on credit –Unearned Revenue, when customers pay in advance for products or services. –Wages, amounts owed to employees for services provided, but for which they have not yet been paid –Taxes payable, amounts owed to governments for sales tax or income taxes accumulated but not yet paid. –Mortgages or loans, money owed to lending institutions or individuals for money they have loaned to the organization

6. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 6 ENGG 401 X2 – Fundamentals of Engineering Management Equity Accounts There are 4 types of accounts affecting Owner’s Equity: –Owner Capital: records owner investment –Owner Withdrawals: records their withdrawals from investment –Revenues and Expenses Incurred over a defined period of time The difference between revenue and expenses defines net income which is either paid out as dividends (after taxes are applied) or rolled back into the organization (often called Retained Earnings)

7. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 7 ENGG 401 X2 – Fundamentals of Engineering Management A sample Income Statement Income Statement Sales Revenue Cost of Goods Sold Gross Profit Expenses Interest Expense Depreciation Expense Utilities Expense Wages Expense Total Expenses Net Income 20000 14000 6000 500 600 100 1200 2400 3600

8. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 8 ENGG 401 X2 – Fundamentals of Engineering Management A sample Statement of Owner’s Equity Statement of Owner’s Equity Opening Balance (from previous period) Add: Net Profit Less: Withdrawals Closing Balance 44400 3600 0 48000

9. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 9 ENGG 401 X2 – Fundamentals of Engineering Management A sample Balance Sheet Balance Sheet Current Assets Cash10000 Current Liabilities Accounts Payable5000 Accounts Receivable20000 Wages Payable25000 Notes Receivable15000 Utilities Payable2000 Marketable Securities25000Long-Term Debt Inventory120000 Notes Payable20000 Capital Assets Bonds Payable600000 Equipment250000Owner’s Equity Buildings500000 Common Stock300000 Goodwill60000 Retained Earnings48000 Total Assets100000 0 Total Liabilities + OE1000000

10. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 10 ENGG 401 X2 – Fundamentals of Engineering ManagementT-Account We have been using these in our sample problems so far It is a helpful tool to help illustrate how the various business transactions affect the various accounts and how they relate to each other The left side is always labeled debit and the right, credit Depending on which side of the balance sheet the account in question is on, entries on either the right or left could be increases or decreases for that account. Account Title Debit sideCredit Side

11. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 11 ENGG 401 X2 – Fundamentals of Engineering Management Double Entry Accounting The most common way to keep accounting records Means that for every business transaction, there is an affect and a record written into at least 2 accounts to always ensure that the accounting equation is in balance Rules to remember: –Increases to assets are debited (entered on left side) of asset accounts. Decreases are credited (entered on right side) –Increases in liabilities are credited (entered on right side) to liability accounts. Decreases are debited (entered on left) –Increases in owner’s equity are credited (right side) and decreases are debited left side) –Revenues (or increases in revenues) are credited to revenue accounts, expenses (or increases) are debited to expense accounts Illustrate: A sale is made for cash, hydro expense paid, cash is used to buy inventory

12. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 12 ENGG 401 X2 – Fundamentals of Engineering Management Organizing Accounts A ledger is a collection of all accounts on the books A Chart of Accounts is a numeric list of accounts Some accounting systems and accountants are familiar with an account numbering system In general the first digit provides a clue to the type of account with subsequent digits providing further detail

13. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 13 ENGG 401 X2 – Fundamentals of Engineering Management Analyzing Transactions Analyzing Transactions is Step 1 in the Accounting Cycle

14. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 14 ENGG 401 X2 – Fundamentals of Engineering Management Journal Entries We have already been doing these, this is Step 2 in the Accounting Cycle Consists the following info: –Date of transaction –Titles of the affected accounts –Dollar amount of each debit or credit –Transaction explanation for future reference Double entry accounting requires that every transaction will affect at least 2 accounts. –Those that affect 3 or more accounts are called Compound Journal Entries Note that the accounts involved do not need to be on opposite sides of the balance sheet –Ex: A cash purchase of furniture vs. purchase of furniture on credit

15. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 15 ENGG 401 X2 – Fundamentals of Engineering Management Journal Entries DateAccount Titles and explanationPRDebitCredit Jan 1 Cash10110000 D. Ludwick, Capital60010000 Jan 3 Furniture1501200 Cash1011200 Jan 7 Accounts Receivable1252000 Cash1011000 Revenue5003000

16. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 16 ENGG 401 X2 – Fundamentals of Engineering Management Journal Entries Date column: the transaction date Account title and explanation: the names of the accounts affected by the transaction. Some journal entries place a short, plain-english, description of the transaction so the record keeper remembers the event PR: Posting Reference column: a place to enter the account number if accounting number is being applied to the books Debit and Credit columns: Places to enter the amounts affecting the specific account for the transaction

17. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 17 ENGG 401 X2 – Fundamentals of Engineering Management Posting Journal Entries Step 3 in the Accounting Cycle The process of posting or transferring entries from the journal to the ledger

18. Dave Ludwick, Dept. of Mech. Eng. Introduction to Financial Statements Summer 2008 18 ENGG 401 X2 – Fundamentals of Engineering Management An example – Jim the Lawyer Sept 1Began his public legal practice by investing $4200 in cash and $3000 in office equipment 1Prepaid 3 months’ rent in advance on suitable office space, $3000 2Purchased office equipment for $420 on credit, and purchased $50 worth of office supplies on credit 4Completed legal work for a client and immediately received payment of $400 cash 8Completed legal work on credit for Forty Third and a Half Bank, $1000 10Paid for the items purchased on credit on Sept 2 14Paid the annual $1200 premium on an insurance policy 15Paid $300 to attend an all-day seminar on Sept 20 regarding ethical legal practices 18Received payment in full from Forty Third and a Half Bank for services provided on Sept 8 20Attended the seminar paid for on Sept 15 24Completed legal work on credit for Great West Realty, $500 28Jim withdrew $150 cash from the practice to pay for personal expenses 29Purchased additional office supplies on credit for $45 30Paid the September utility bill of $175